Insurers Scale Back Corporate Liability Policies

By JONATHAN D. GLATER and JOSEPH B. TREASTER

Published: September 7, 2002

Shellshocked by corporate scandals and fearful of the hefty payments they will have to make to settle shareholder lawsuits, the big commercial insurance companies are cutting back sharply on liability coverage for American corporations, their directors and senior executives.

The cutbacks are taking the form of higher deductibles and lower limits on overall coverage. But the insurance companies are also demanding that corporations pay part of any court settlements or jury awards out of their own pockets. As a result, corporations in telecommunications, energy, financial services and pharmaceuticals -- where the risk of being sued is thought to be highest -- could face payments of up to half of the cost of any settlement.

The three leaders in this line of coverage -- the American International Group, the Chubb Group and Hartford Financial Services -- have already begun requiring some customers to share the expense of settlements.

The cutbacks effectively limit the size of policies insurance companies will sell to any one company, said Andrew Marcell, who is in charge of insurance for directors and corporate officers at Guy Carpenter, a New York reinsurance broker and a unit of the Marsh & McLennan Companies.

''Companies that until recently were willing to provide $50 million in coverage are now offering $25 million, and companies that offered $25 million are now providing $10 million to $15 million,'' Mr. Marcell said.

Enron had $350 million in this kind of coverage and some corporations had been buying up to $1 billion worth. But now, Mr. Marcell said, ''$250 million in coverage is pretty hard to come by.''

The sharing of the burden of settlements may also leave directors' and officers' personal assets exposed, lawyers said.

''This is very bad news for directors and officers,'' said Michael Young, a partner at the law firm of Willkie Farr & Gallagher in New York who often represents directors and officers. ''The insurance industry is sending out the word that for outside directors, insurance that provides 100 percent protection is going to be increasingly difficult to get and companies are going to have to pay through the nose for it.''

John Keogh, a unit president of the American International Group, said that some corporations could avoid sharing the costs of lawsuits with insurance companies and get full coverage up to limits of their policies by paying higher premiums. But David H. McElroy, who is in charge of this kind of insurance at Hartford Financial Services, said the riskiest clients could not get full coverage at any price.

The insurers say they are merely acting in self-defense as they watch corporate giant after corporate giant collapse as they come under fire for deceptive accounting and management abuses that have drained companies like WorldCom, Global Crossing and Tyco of hundreds of millions in corporate money.

As share prices of these companies have plunged, shareholders have turned to lawsuits in an attempt to recover at least some of their losses.

Combining the expected costs from some of the latest lawsuits, which are still in their early stages, and scores of others that have been working their way through the courts over the last few years, insurers estimate that they will have to pay out $7.5 billion this year on liability policies for directors and officers -- but they collected only $4.5 billion in premiums.

''The expected claims paid out are going to be multiples of the premiums that have been collected,'' said Mr. Keogh of A.I.G. He would not comment on specific numbers. Some insurers said that they expected the actual losses to be lower, but that the industry would still lose money this year. Quietly, several insurers have also begun trying to cancel certain policies, arguing that corporate fraud makes them void -- a nightmare for executives.

The cutback in liability coverage and increases in premiums are hitting corporations hard. Bruce S. Zaccanti, an insurance consultant at Ernst & Young, said a nationwide real estate management company he had been advising paid $3 million for $100 million in coverage last year. This year, the company's premium jumped to $4.5 million for $70 million in coverage. On top of that, he said, the deductible has jumped to $15 million from $5 million.

By forcing the companies to share the cost of settlements, the insurers also hope to prod them to fight harder to keep those costs down. When all the costs have been covered, the insurers said, the corporations are often eager to settle quickly -- rather than work for a smaller settlement.

''There is no doubt in our minds that insureds' settlement behavior has been less reluctant than maybe it once was when there was an economic alignment,'' said Tony Galban, vice president and manager of directors and officers liability insurance underwriting at Chubb Specialty, a subsidiary of Chubb & Son.

In recent years, the average size of settlements in securities lawsuits has increased drastically, rising to $16 million in 2001, according to the Securities Class Action Clearinghouse, an organization at Stanford University that tracks securities litigation. Before 1995, when a law was passed making it tougher to bring securities fraud claims, the average settlement was less than half that amount.

The possibility that individual directors and officers could be forced to dip into their own wealth may make it harder to recruit executives to serve on corporate boards, said Brooks Chamberlin, head of the global insurance practice at Korn/Ferry International, an executive search firm. Fearful of personal liability, more and more recruits are conducting their own due diligence on prospective employers, he said.

Smaller companies, companies with financial problems, companies in certain industries perceived to have a higher incidence of fraud, and companies with fewer hard assets but sizable market capitalizations will have more trouble, Mr. Chamberlin said.

According to Mr. Young of Willkie Farr & Gallagher, directors want some assurance that somebody else will be able to pay any settlement or damage award.

''What if the company goes into bankruptcy? Then who covers?'' he asked rhetorically. ''Or what if the company's just not wealthy enough?''

The changes have already had the odd effect of leading to the creation of a new type of policy that will protect only independent directors. A.I.G. will sell the policies that cannot be canceled even in the case of management fraud, Mr. Keogh said.

But Gregory M. Schmidt, general counsel at the LIN TV Corporation, an owner of television stations in several states, wondered whether companies might choose not to take on the additional cost of these policies and instead promise to cover any settlement costs owed by the directors. ''The question is whether that's going to be satisfactory'' to the directors and officers, he said.

LIN's policies are not up for renewal until March, he said, but executives at the company are monitoring changes the insurers are announcing.